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Efficient
Market
Hypothesis
Dr. Lokanandha Reddy Irala(www.irala.org)
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Efficient Market Hypothesis
 At any given time prices fully reflect all available information
on a particular stock and/or market (Fama, 1970)
 No investor has an advantage in predicting a return on a
stock price since no one has access to information not
already available to everyone else.
 As all market participants are privy to the same information,
no one will have the ability to "out-profit" anyone else.
 Prices become not predictable but random
 No investment pattern can be discerned and a planned
approach to investment cannot be successful.
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Dr. Lokanandha Reddy Irala(www.irala.org)
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Efficient Market Hypothesis
 Possibility of anomalies not dismissed
- generation of superior profits possible.
 Market efficiency does not require prices to be equal to fair value
all of the time
- Prices may be over or undervalued, but only in random
occurrences, so they eventually resort back to their mean
value.
 As the price deviations are random, investment strategies that
result in beating the market cannot be consistent phenomena.
 An investor who outperforms the market does so not out of skill
but out of luck.
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Dr. Lokanandha Reddy Irala(www.irala.org)
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How a market becomes efficient
 Investors must perceive that a market is inefficient and possible to
beat - Investment strategies intended to manipulate inefficiencies
are actually the fuel that keep a market efficient.
 A market has to be large and liquid.
 Information has to be widely available, in terms of accessibility
and cost, and released to investors at more or less the same time.
 Transaction costs have to be cheaper than the expected profits of
an investment strategy.
 Investors should also have enough funds to take advantage of
inefficiency until, according to the EMH, it disappears again.
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Dr. Lokanandha Reddy Irala(www.irala.org)
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Degrees of Efficiency
 Strong efficiency
- All information in a market, whether public or private, is
accounted for in a stock price. Not even insider information
could give an investor an advantage
 Semi-strong efficiency
- All public information is calculated into a stock’s current share
price. Neither fundamental nor technical analysis can be used
to achieve superior gains.
 Weak efficiency
- All past prices of a stock are reflected in today’s stock price.
Therefore, technical analysis cannot be used to predict and
beat a market
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Dr. Lokanandha Reddy Irala(www.irala.org)
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